1. Accounting Standard (AS) 29
Provisions, Contingent Liabilities and
Contingent Assets
Introduction
Financial statements are prepared to summarize the end-result of all the business
activities by an enterprise during an accounting period in monetary terms. These
business activities vary from one enterprise to other. To compare the financial
statements of various reporting enterprises poses some difficulties because of
the divergence in the methods and principles adopted by these enterprises in
preparing their financial statements. In order to make these methods and
principles uniform and comparable to the extent possible – standards are
evolved.
What are Accounting Standards?
Accounting Standards are the statements of code of practice of the regulatory
accounting bodies that are to be observed in the preparation and presentation of
financial statements. In layman terms, accounting standards are the written
documents issued by the expert institutes or other regulatory bodies covering
various aspects of measurement, treatment, presentation and disclosure of
accounting transactions.
What are the objectives of Accounting Standards?
The basic objective of Accounting Standards is to remove variations in the
treatment of several accounting aspects and to bring about standardization in
presentation. They intent to harmonize the diverse accounting policies followed
in the preparation and presentation of financial statements by different reporting
enterprises so as to facilitate intra-firm and inter-firm comparison.
Who issues Accounting Standards in India?
The Institute of Chartered Accountants of India (ICAI) recognizing the need to
harmonize the diverse accounting policies and practices at present in use in
India constituted Accounting Standards Board (ASB) on April 21, 1977. The
main role of ASB is to formulate Accounting Standards from time to time.

2. What is the duty of Statutory Auditor for Compliance with Accounting
Standards?
Section 211(3A) of Companies Act, 1956 provides that every profit and loss
account and balance sheet of the company shall comply with the accounting
standards.
The statutory auditors are required to make qualification in their report in case
any item is treated differently from the prescribed Accounting Standard.
However, while qualifying, they should consider the materiality of the relevant
item. In addition to this Section 227(3) (d) of Companies Act, 1956 requires an
auditor to report whether, in his opinion, the profit and loss account and balance
sheet are complied with the accounting standards referred to in Section 211(3C)
of Companies Act, 1956.
How many Accounting Standards have been prescribed? Are these
applicable to all companies irrespective of its size?
In all 29 Accounting Standards have been prescribed. However their
applicability is dependent on its size – Level I / II / III Company. The following
table lists out the Accounting Standards and its applicability.
Level I Company:
Enterprises, which fall in any one or more of the following categories, at any
time during the accounting period, are classified as Level I enterprises:
i) Enterprises whose equity or debt securities are listed whether in India or
outside India.
ii) Enterprises, which are in the process of listing their equity or debt securities
as evidenced by the board of directors’ resolution in this regard.
iii) Banks including co-operative banks.
iv) Financial Institutions
v) Enterprises carrying on insurance business.
vi) All commercial, industrial and business reporting enterprises whose turnover
for the immediately preceding accounting period on the basis of audited

3. financial statements exceeds Rs. 500 million. Turnover does not include ‘other
income’.
vii) All commercial, industrial and business reporting enterprises having
borrowings, including public deposits, in excess of Rs. 100 million at any time
during the accounting period.
viii) Holding and subsidiary enterprises of any one of the above at any time
during the accounting period.
Level II Company:
Enterprises, which are, not Level I enterprises but fall in any one or more of the
following categories are classified as Level II enterprises;
i) All commercial, industrial and business reporting enterprises whose turnover
for the immediately preceding accounting period on the basis of audited
financial statements exceeds Rs. 4 million, but does not exceed Rs. 500 million.
Turnover does not include ‘other income’.
ii)All commercial, industrial and business reporting enterprises having
borrowing, including public deposits, in excess of Rs. 10 million but not in
excess of Rs. 100 million at any time during the accounting period.
iii) Holding and subsidiary enterprises of any one of the above at any time
during the accounting period.
Level III Company:
Enterprises, which are not covered under Level I and Level II are considered as
Level III enterprises.
Applicability
Level II and Level III enterprises are considered as SMEs
Level I enterprises are required to comply fully with all the accounting
standards.
Accounting Standard (AS) 29,
‘Provisions, Contingent Liabilities and Contingent Assets’, issued by the
Council of the Institute of Chartered Accountants of India, comes into effect in

4. respect of accounting periods commencing on or after 1-4-2004. This Standard
is mandatory in nature from that date:
(a) in its entirety, for the enterprises which fall in any one or more of the
following categories, at any time during the accounting period:
(i) Enterprises whose equity or debt securities are listed whether in India or
outside India.
(ii) Enterprises which are in the process of listing their equity or debt securities
as evidenced by the board of directors’ resolution in this regard.
(iii) Banks including co-operative banks.
(iv) Financial institutions.
(v) Enterprises carrying on insurance business.
(vi) All commercial, industrial and business reporting enterprises whose
turnover for the immediately preceding accounting period on the basis of
audited financial statements exceeds Rs. 50 crore. Turnover does not include
‘other income’.
(vii) All commercial, industrial and business reporting enterprises having
borrowings, including public deposits, in excess of Rs. 10 crore at any time
during the accounting period.
(viii) Holding and subsidiary enterprises of any one of the above at any time
during the accounting period.
(b) in its entirety, except paragraph 67, for the enterprises which do not fall in
any of the categories in (a) above but fall in any one or more of the following
categories:
(i) All commercial, industrial and business reporting enterprises whose turnover
for the immediately preceding accounting period on the basis of audited
financial statements exceeds Rs. 40 lakh but does not exceed Rs. 50 crore.
Turnover does not include ‘other income’.
(ii) All commercial, industrial and business reporting enterprises having
borrowings, including public deposits, in excess of Rs. 1 crore but not in excess
of Rs. 10 crore at any time during the accounting period.

5. (iii) Holding and subsidiary enterprises of any one of the above at any time
during the accounting period.
(c) in its entirety, except paragraphs 66 and 67, for the enterprises, which do not
fall in any of the categories in (a) and (b) above. Where an enterprise has been
covered in any one or more of the categories in (a) above and subsequently,
ceases to be so covered, the enterprise will not qualify for exemption from
paragraph 67 of this Standard, until the enterprise ceases to be covered in any of
the categories in (a) above for two consecutive years.
Objective of Accounting Standard (AS) 29 Provisions, Contingent
Liabilities and Contingent Assets
The objective of this Statement is to ensure that appropriate recognition criteria
and measurement bases are applied to provisions and contingent liabilities and
that sufficient information is disclosed in the notes to the financial statements to
enable users to understand their nature, timing and amount.
The objective of this Statement is also to lay down appropriate accounting for
contingent assets.
Scope of Accounting Standard (AS) 29 Provisions, Contingent Liabilities and
Contingent Assets
1. This Statement should be applied in accounting for provisions and contingent
liabilities and in dealing with contingent assets, except:
(a) those resulting from financial instruments4 that are carried at fair value;
(b) those resulting from executory contracts, except where the contract is
onerous ;
(c) those arising in insurance enterprises from contracts with policy-holders; and
(d) those covered by another Accounting Standard.
2. This Statement applies to financial instruments (including guarantees) that
are not carried at fair value.
3. Executory contracts are contracts under which neither party has performed
any of its obligations or both parties have partially performed their obligations

6. to an equal extent. This Statement does not apply to Executory contracts unless
they are onerous.
4. This Statement applies to provisions, contingent liabilities and contingent
assets of insurance enterprises other than those arising from contracts with
policy-holders.
5. Where another Accounting Standard deals with a specific type of provision,
contingent liability or contingent asset, an enterprise applies that Statement
instead of this Statement. For example, certain types of provisions are also
addressed in Accounting Standards on:
(a) Construction contracts (see AS 7, Construction Contracts);
(b) Taxes on income (see AS 22, Accounting for Taxes on Income);
(c) Leases (see AS 19, Leases). However, as AS 19 contains no specific
requirements to deal with operating leases that have become onerous, this
Statement applies to such cases; and
(d) Retirement benefits (see AS 15, Accounting for Retirement Benefits in the
Financial Statements of Employers).
6. Some amounts treated as provisions may relate to the recognition of revenue,
for example where an enterprise gives guarantees in exchange for a fee. This
Statement does not address the recognition of revenue. AS 9, Revenue
Recognition, identifies the circumstances in which revenue is
recognized and provides practical guidance on the application of the recognition
criteria. This Statement does not change the requirements of AS 9.
7. This Statement defines provisions as liabilities which can bemeasured only
by using a substantial degree of estimation. The term‘provision’ is also used in
the context of items such as depreciation, impairment of assets and doubtful
debts: these are adjustments to the carrying amounts of assets and are not
addressed in this Statement.
8. Other Accounting Standards specify whether expenditures are treated as
assets or as expenses. These issues are not addressed in this Statement.
Accordingly, this Statement neither prohibits nor requires capitalization of the
costs recognized when a provision is made.

7. 9. This Statement applies to provisions for restructuring (including
discontinuing operations). Where a restructuring meets the definition of a
discontinuing operation, additional disclosures are required by AS 24,
Discontinuing Operations.
Definitions of Accounting Standard (AS) 29 Provisions, Contingent
Liabilities and Contingent Assets
10. The following terms are used in this Statement with the meanings specified:
A provision is a liability which can be measured only by using a substantial
degree of estimation.
A liability is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of
resources embodying economic benefits.
An obligating event is an event that creates an obligation that results in an
enterprise having no realistic alternative to settling that obligation. A contingent
liability is:
(a) a possible obligation that arises from past events and the existence of which
will be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the enterprise; or
(b) a present obligation that arises from past events but is not recognised
because:
(i) it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.
A contingent asset is a possible asset that arises from past events the existence
of which will be confirmed only by the occurrence or nonoccurrence of one or
more uncertain future events not wholly within the control of the enterprise.
Present obligation - an obligation is a present obligation if, based on the
evidence available, its existence at the balance sheet date is considered
probable, i.e., more likely than not. Possible obligation - an obligation is a
possible obligation if, based on the evidence available, its existence at the
balance sheet date is considered not probable.

8. A restructuring is a programme that is planned and controlled by management,
and materially changes either:
(a) the scope of a business undertaken by an enterprise; or
(b) the manner in which that business is conducted.
11. An obligation is a duty or responsibility to act or perform in a certain way.
Obligations may be legally enforceable as a consequence of a binding contract
or statutory requirement. Obligations also arise from normal business practice,
custom and a desire to maintain good business relations or act in an equitable
manner.
12. Provisions can be distinguished from other liabilities such as trade payables
and accruals because in the measurement of provisions substantial degree of
estimation is involved with regard to the future expenditure required in
settlement. By contrast:
(a) trade payables are liabilities to pay for goods or services that have been
received or supplied and have been invoiced or formally agreed with the
supplier; and
(b) accruals are liabilities to pay for goods or services that have been received or
supplied but have not been paid, invoiced or formally agreed with the supplier,
including amounts due to employees.
Although it is sometimes necessary to estimate the amount of accruals, the
degree of estimation is generally much less than that for provisions.
13. In this Statement, the term ‘contingent’ is used for liabilities and assets that
are not recognized because their existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the enterprise. In addition, the term ‘contingent
Liability’ is used for liabilities that do not meet the recognition criteria.
Recognition of Provisions
Provisions
14. A provision should be recognized when:
(a) an enterprise has a present obligation as a result of a past event;

9. (b) it is probable that an outflow of resources embodying economic benefits will
be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation. If these
conditions are not met, no provision should be recognized.
Present Obligation
15. In almost all cases it will be clear whether a past event has given rise to a
present obligation. In rare cases, for example in a lawsuit, it may be disputed
either whether certain events have occurred or whether those events result in a
present obligation. In such a case, an enterprise determines whether a present
obligation exists at the balance sheet date by taking account of all available
evidence, including, for example, the opinion of experts. The evidence
considered includes any additional evidence provided by events after the
balance sheet date. On the basis of such evidence:
(a) where it is more likely than not that a present obligation exists at the balance
sheet date, the enterprise recognizes a provision (if the recognition criteria are
met); and
(b) where it is more likely that no present obligation exists at the balance sheet
date, the enterprise discloses a contingent liability, unless the possibility of an
outflow of resources embodying economic benefits is remote.
Past Event
16. A past event that leads to a present obligation is called an obligating event.
For an event to be an obligating event, it is necessary that the enterprise has no
realistic alternative to settling the obligation created by the event.
17. Financial statements deal with the financial position of an enterprise at the
end of its reporting period and not its possible position in the future. Therefore,
no provision is recognized for costs that need to be incurred to operate in the
future. The only liabilities recognized in an enterprise’s balance
sheet are those that exist at the balance sheet date.
18. It is only those obligations arising from past events existing independently
of an enterprise’s future actions (i.e. the future conduct of its business) that are
recognized as provisions. Examples of such obligations are penalties or clean-
up costs for unlawful environmental damage, both of which would lead to an
outflow of resources embodying economic benefits in settlement regardless of

10. the future actions of the enterprise. Similarly, an enterprise recognizes a
provision for the decommissioning costs of an oil installation to the extent that
the enterprise is obliged to rectify damage already caused. In contrast, because
of commercial pressures or legal requirements, an enterprise may intend or need
to carry out expenditure to operate in a particular way in the future (for
example, by fitting smoke filters in a certain type of factory).
Because the enterprise can avoid the future expenditure by its future actions, for
example by changing its method of operation, it has no present obligation for
that future expenditure and no provision is recognized.
19. An obligation always involves another party to whom the obligation is
owed. It is not necessary, however, to know the identity of the party to whom
the obligation is owed – indeed the obligation may be to the public at large.
20. An event that does not give rise to an obligation immediately may do so at a
later date, because of changes in the law. For example, when environmental
damage is caused there may be no obligation to remedy the consequences.
However, the causing of the damage will become an obligating event when a
new law requires the existing damage to be rectified.
21. Where details of a proposed new law have yet to be finalized, an obligation
arises only when the legislation is virtually certain to be enacted. Differences in
circumstances surrounding enactment usually make it impossible to specify a
single event that would make the enactment of a law virtually certain. In many
cases it will be impossible to be virtually certain of the enactment of a law until
it is enacted.
Probable Out flow of Resources Embodying Economic Benefits
22. For a liability to qualify for recognition there must be not only a present
obligation but also the probability of an outflow of resources embodying
economic benefits to settle that obligation. For the purpose of this Statement, an
outflow of resources or other event is regarded as probable if the event is more
likely than not to occur, i.e., the probability that the event will occur is greater
than the probability that it will not. Where it is not probable that a present
obligation exists, an enterprise discloses a contingent liability, unless the
possibility of an outflow of resources embodying economic benefits is remote.

11. 23. Where there are a number of similar obligations (e.g. product warranties or
similar contracts) the probability that an outflow will be required in settlement
is determined by considering the class of obligations as a whole. Although the
likelihood of outflow for any one item may be small, it may well
be probable that some outflow of resources will be needed to settle the class of
obligations as a whole. If that is the case, a provision is recognized (if the other
recognition criteria are met).
Reliable Estimate of the Obligation
24. The use of estimates is an essential part of the preparation of financial
statements and does not undermine their reliability. This is especially true in the
case of provisions, which by their nature involve a greater degree of estimation
than most other items. Except in extremely rare cases, an
Enterprise will be able to determine a range of possible outcomes and can
therefore make an estimate of the obligation that is reliable to use in recognizing
a provision.
25. In the extremely rare case where no reliable estimate can be made, a liability
exists that cannot be recognized. That liability is disclosed as a contingent
liability.
Contingent Liabilities
26. An enterprise should not recognize a contingent liability.
27. A contingent liability is disclosed, as required by paragraph 68, unless the
possibility of an outflow of resources embodying economic benefits is remote.
28. Where an enterprise is jointly and severally liable for an obligation, the
part of the obligation that is expected to be met by other parties is treated as a
contingent liability. The enterprise recognizes a provision for the part of the
obligation for which an outflow of resources embodying economic benefits is
probable, except in the extremely rare circumstances where no reliable estimate
can be made .
29. Contingent liabilities may develop in a way not initially expected.
Therefore, they are assessed continually to determine whether an outflow of
resources embodying economic benefits has become probable. If it becomes
probable that an outflow of future economic benefits will be required for an
item previously dealt with as a contingent liability, a provision is recognised in
accordance with paragraph 14 in the financial statements of the period in which
the change in probability occurs (except in the extremely rare circumstances
where no reliable estimate can be made).

12. Contingent Assets
30. An enterprise should not recognise a contingent asset.
31. Contingent assets usually arise from unplanned or other unexpected
events that give rise to the possibility of an inflow of economic benefits to the
enterprise. An example is a claim that an enterprise is pursuing through legal
processes, where the outcome is uncertain.
32. Contingent assets are not recognized in financial statements since this
may result in the recognition of income that may never be realized. However,
when the realization of income is virtually certain, then the related asset is not a
contingent asset and its recognition is appropriate.
33. A contingent asset is not disclosed in the financial statements. It is
usually disclosed in the report of the approving authority (Board of Directors in
the case of a company, and, the corresponding approving authority in the case of
any other enterprise), where an inflow of economic benefits is probable.
34. Contingent assets are assessed continually and if it has become virtually
certain that an inflow of economic benefits will arise, the asset and the related
income are recognized in the financial statements of the period in which the
change occurs.
Measurement
Best Estimate
35. The amount recognized as a provision should be the best estimate of the
expenditure required to settle the present obligation at the balance sheet date.
The amount of a provision should not be discounted to its present value.
36. The estimates of outcome and financial effect are determined by the
judgment of the management of the enterprise, supplemented by experience of
similar transactions and, in some cases, reports from independent experts. The
evidence considered includes any additional evidence provided by events after
the balance sheet date.

13. 37. The provision is measured before tax; the tax consequences of the
provision, and changes in it, are dealt with under AS 22, Accounting for Taxes
on Income.
Risks and Uncertainties
38. The risks and uncertainties that inevitably surround many events and
circumstances should be taken into account in reaching the best estimate of a
provision.
39. Risk describes variability of outcome. A risk adjustment may increase the
amount at which a liability is measured. Caution is needed in making judgments
under conditions of uncertainty, so that income or assets are not overstated and
expenses or liabilities are not understated. However, uncertainty does not justify
the creation of excessive provisions or a deliberate overstatement of liabilities.
For example, if the projected costs of a particularly adverse outcome are
estimated on a prudent basis, that outcome is not then deliberately treated as
more probable than is realistically the case. Care is needed to avoid duplicating
adjustments for risk and uncertainty with consequent overstatement of a
provision.
40. Disclosure of the uncertainties surrounding the amount of the expenditure is
made under paragraph 67(b).
Future Events
41. Future events that may affect the amount required to settle an obligation
should be reflected in the amount of a provision where there is sufficient
objective evidence that they will occur.
42. Expected future events may be particularly important in measuring
provisions. For example, an enterprise may believe that the cost of cleaning up a
site at the end of its life will be reduced by future changes in technology. The
amount recognized reflects a reasonable expectation of technically qualified,
objective observers, taking account of all available evidence as to the
technology that will be available at the time of the clean-up. Thus, it is
appropriate to include, for example, expected cost reductions associated with
increased experience in applying existing technology or the expected cost of
applying existing technology to a larger or more complex clean-up operation
than has previously been carried out. However, an enterprise does not anticipate
the development of a completely new technology for cleaning up unless it is
supported by sufficient objective evidence.

14. 43. The effect of possible new legislation is taken into consideration in
measuring an existing obligation when sufficient objective evidence exists that
the legislation is virtually certain to be enacted. The variety of circumstances
that arise in practice usually makes it impossible to specify a single event that
will provide sufficient, objective evidence in every case. Evidence is required
both of what legislation will demand and of whether it is virtually certain to be
enacted and implemented in due course. In many cases sufficient objective
evidence will not exist until the new legislation is enacted.
Expected Disposal of Assets
44. Gains from the expected disposal of assets should not be taken into
account in measuring a provision.
45. Gains on the expected disposal of assets are not taken into account in
measuring a provision, even if the expected disposal is closely linked to the
event giving rise to the provision. Instead, an enterprise recognizes gains on
expected disposals of assets at the time specified by the Accounting Standard
dealing with the assets concerned.
Reimbursements
46. Where some or all of the expenditure required settling a provision is
expected to be reimbursed by another party, the reimbursement should be
recognized when, and only when, it is virtually certain that reimbursement will
be received if the enterprise settles the obligation. The reimbursement should be
treated as a separate asset. The amount recognized for the reimbursement should
not exceed the amount of the provision.
47. In the statement of profit and loss, the expense relating to a provision may
be presented net of the amount recognized for a reimbursement.
48. Sometimes, an enterprise is able to look to another party to pay part or all
of the expenditure required to settle a provision (for example, through insurance
contracts, indemnity clauses or suppliers’ warranties). The other party may
either reimburse amounts paid by the enterprise or pay the amounts directly.
49. In most cases, the enterprise will remain liable for the whole of the
amount in question so that the enterprise would have to settle the full amount if
the third party failed to pay for any reason. In this situation, a provision is
recognized for the full amount of the liability, and a separate asset for the
expected reimbursement is recognized when it is virtually certain that
reimbursement will be received if the enterprise settles the liability.

15. 50. In some cases, the enterprise will not be liable for the costs in question if
the third party fails to pay. In such a case, the enterprise has no liability for
those costs and they are not included in the provision.
51. As noted in paragraph 28, an obligation for which an enterprise is jointly
and severally liable is a contingent liability to the extent that it is expected that
the obligation will be settled by the other parties.
Changes in Provisions
52. Provisions should be reviewed at each balance sheet date and adjusted to
reflect the current best estimate. If it is no longer probable that an outflow.
Example 1: Warranties
A manufacturer gives warranties et the time of sale to purchasers of its product.
Under the terms of the contract for the manufacturer undertakes to make good,
by repairs or replacement, manufacturer defects that become apparent within
three years from the date of sale. On past experience, it is probable (i.e. more
likely than not) that there will be some claims under the warranties.
Present obligation as a result of a past obligating event- The obligating event is
the sale of the product with a warranty, which gives rise to an obligation
An outflow of resources embodying economics benefits in settlement- Probable
for the warranties as a whole.
Conclusion – A provision is recognized for the best estimate of the costs of
making good under the warranty products sold before the balance sheet date.
Example 2: Contaminated Land- Legislation Virtually Certain to be
Enacted
An enterprise in the oil industry causes contaminated but does not clean up
because there is no legislation requiring cleaning up, and the enterprise has been
contaminating land for several years. At 31 March 2005 it is virtually certain
that a law requiring a clean up of land already contaminated will be enacted
shortly after the year end.

16. Present obligation as a result of a past obligating event- he obligating event is
the contamination of the land because of the virtually certainty of legislation
requiring cleaning up.
An outflow of resources embodying economics benefits in settlement- Probable.
Conclusion - A provision is recognized for the best estimate of the costs of the
clean up.
Example 3: Offshore Oilfield
An enterprise operates an offshore oilfield where its licensing agreement
requires it to remove the oil rig at the end of production and restore the seabed.
Ninety percent of the eventual cost related to the removal of the oil rig and
restoration of damage caused by building it, and ten percent arise through the
extraction of oil. At the balance sheet date, the rig has been constructed but no
oil has been extracted.
Present obligation as a result of past obligating event- The construction of the
oil rig created an obligation under the terms of the license to remove the rig and
restore the seabed and is thus as obligating event. At the balance sheet date,
however, there is no obligation to rectify the damage that will be caused by
extraction of oil.
An outflow of resources embodying economics benefits in settlement- Probable.
Conclusion- A provision is recognized for the best estimate of ninety percent of
the eventual costs that relate to the removal of the oil rig and restoration of
damage caused by building it. There coasts are included as part of the cost of
the oil rig. The ten percent of costs that arise through the extraction of oil are
recognized as a liability when the oil is extracted.
Example 4: Refunds Policy
A retail store has a policy of refunding purchases by dissatisfied customers,
even though it is under no legal obligation to do so. Its policy of making refunds
is generally known.
Present obligation as a result of a past obligating event- The obligating event is
the sale of the product, which gives rise to an obligation because obligating also
arise from normal business practice, custom and a desire to a maintain good
business relations or act in an equitable manner
Outflows of resources embodying economic benefit in settlement–Probable, a
proportion of goods are returned for refund.

17. Conclusion – A provision is recognized for the best estimate of the costs of
refunds.
Example 5: Legal Requirement to Fit Smoke Filters
Under new legislation, an enterprise is required to fit smoke filters to its
factories by 30 September 2005. The enterprise has not fitted the smoke filters.
(a) At the balance sheet date of 31 March 2005
Present obligation as a result of a past obligating event – There is no obligation
because there is no obligating event either for the costs of fitting smoke filters
or for fines under the legislation
Conclusion – No provision is recognized for the cost of fitting the smoke
filters.
(b) At the balance sheet date of 31 March 2006
Present obligations as a result of a past obligating event – There is still no
obligation for the costs of fitting smoke filters because no obligating event has
occurred (the fitting of the filters). However, an obligation might arise to pay
fines o penalties under the legislation because the obligating event has occurred
(the non-complaint operation of the factory).
An outflow of resources embodying economic benefits in settlement -
Assessment of probability of incurring fines and fines and penalties by non-
compliant operation depends on the details of the legislation and the stringency
of the enforcement regime.
Conclusion – No provision is recognized for the costs of fitting smoke filters.
However, a provision is recognized for the best estimate of any fines and
penalties that are more likely than not to be imposed.
Example 6: Staff retraining as a Result of Changes in the Income Tax
System
The government introduces a number of changes to the income tax system. As a
result of these changes, an enterprise in the financial services sector will need to
retrain a large proportion of its administrative and sales workforce in order to

18. ensure continued compliance with financial services regulation. At the balance
sheet date, no retraining of staff has taken place.
Present obligation as a result of past obligating event – There is no obligation
because no obligating event (retraining) has taken place.
Conclusion – No provision is recognized.
Example 7: A Single Guarantee
During 2004-05, Enterprise A gives a guarantee of certain borrowing of
Enterprise B, whose financial condition at that time is sound. During 2005-06,
the financial condition of Enterprise B deteriorates and at 30 September 2005
Enterprise B goes into liquidation..
(a) At 31 March 2005
Present obligation as a result of a past obligating event – The obligating event is
the giving of the guarantee, which gives rise to an obligation.
An outflow of resources embodying economics benefits in settlement – No
outflow of benefits is probable at 31 March 2005.
Conclusion – No provision is recognized. The guarantee is disclosed as a
contingent liability unless the probability of any is regarded as remote At 31
March 2006
Present obligation as a result of a past obligating event – The obligating event is
the giving of the guarantee, which gives to a legal obligation.
Conclusion – A provision is recognized for the best estimate of the obligation.
Note: This example deals with a single guarantee. If an enterprise has a
portfolio of similar guarantee, it will assess that portfolio as a whole in
determining whether an outflow of resources embodying economic benefit is
probable. Where an enterprise gives guarantees in exchange for a fee, revenue is
recognized under AS 9, Revenue recognition.
Example 8: A Court Case
After a wedding in 2004-05, ten people died, possibly as a result of food
poisoning from products sold by the enterprise. Legal proceedings are started
seeking damages from the enterprise but it disputes liability. Up to the date of
approval of the financial statements for the year 31 March 2005, the enterprise’s
lawyers advice that it is probable that the enterprise will not be found liable.
However, when the enterprise prepares the financial statements for the year 31

19. March 2006, its lawyer’s advice that, owing to developments in the case, it is
probable that the enterprise will be found liable.
(a) At 31 March 2005
Present obligation as a result of a past obligating event – On the basis of the
evidence available when the financial statements were approved, there is no
present obligation as a result of past events.
Conclusion – No provision is recognized. The matter is disclosed as a
contingent liability unless the probability of any outflow is regarded as remote
(b) At 31 March 2006
Present obligation as a result of a past obligating event – On the basis of the
evidence available, there is a present obligation.
Conclusion – A provision is recognized for the best estimate of the amount to
settle the obligation.
Example 9A: Refurbishment Costs – No Legislative Requirement
A furnace has a lining that needs to be replaced every five years for technical
reasons. At the balance sheet date, the lining has been in use for three years.
Present obligation as a result of a past obligating event- There is no present
obligation.
Conclusion – No provision is recognized.
The cost of replacing the lining is not recognized because, at the balance sheet
date, no obligation to replace the lining exits independently of the company’s
future actions – even the intention to incur the expenditure depends on the
company deciding to continue operating the furnace or to replace the lining.
Example 9B: Refurbishment Costs – Legislative Requirement
An Airline is required by law to overhaul its aircraft once every three years.
Present obligation as a result of a past obligating event – There is no present
obligation.
Conclusion – No provision is recognized.
The costs of overhauling aircraft are not recognized as a provision for the same
reason as the cost of replacing the lining is not recognized as a provision in
example 9A. Even a legal requirement to overhaul does not make the cost of the

20. overhaul a liability, because no obligation exits to overhaul the aircraft
independently of the enterprise’s future actions – the enterprise could avoid the
future expenditure by its future actions, for example by selling the aircraft.
Webliography
http://www.joshiapte.com/Accounting%20Standards.aspx